Today on Tax Tuesday, Anderson attorneys Eliot Thomas, Esq., and Amanda Wynalda, Esq. delve into listener questions around inheritance taxes on property and stocks, strategies to minimize capital gains when relocating homes, and the intricacies of 1031 exchanges and syndication investments. Additional topics include LLC taxation, depreciation on rental properties, and the choice between independent contracting and LLC formation in Florida.
Submit your tax question to taxtuesday@andersonadvisors.com
Highlights/Topics:
- Is there any capital gains tax when my son inherits my property or stock? – It depends. With traditional stock it’s fair market value when you pass. There’s no tax to transfer it.
- I’m selling my home in South Florida soon and we like to relocate to North Carolina. I would like to reinvest a portion of a rental property into a rental property and another smaller home when I move to North Carolina. What’s the best way to pay the least amount of capital gains taxes after selling my Florida home? – We’re assuming a primary residence, and considering the 121 exclusion. If you lived there 2 of the last 5 years….
- How does a 1031 exchange work? What about a reverse 1031?- If you have an asset used as a rental, not being flipped, you want to defer the gain by buying a “replacement”. Time frames are very strict- 45 days. You need a qualified intermediary.
- If I’m selling a property, all the investors wanna roll their money into a future investment through a 1031 exchange. Is there a legal way to still do a 1031 for the investors that want to participate? – If this is a partnership, that partnership owns the property. It could be changed to a ‘Tenancy in Common’….
- I have recently opened my Wyoming LLC, got up a bank account, a business bank account for the LLC,and funded the LLC out of my personal account. I have since used the deposit of funds to make a limited partnership investment in a syndication, very popular investment. How do I best document these transactions for tax purposes? – Everything goes back to bookkeeping. Troy from our bookkeeping dept says with any capital contributions to the “equity account” for a syndication, you will receive a K1, that you can adjust at tax time based on the loss or gain of the company.
- If my LLC distributes dividends to the partners, do the partners pay tax from the money they receive from the LLC?
- Should I take depreciation on a rental property if I don’t have a tenant that year or should I wait until finishing repair? Although it is habitable. I’m a licensed realtor by the way. – When you purchase the property, the building can be depreciated a little bit each year, but land is not depreciable until it is sold. Check out cost segregation and bonus segregation. When it is advertised or posted as “Available for Rent” and truly rentable, that is when you MUST begin taking depreciation. As a realtor, you may aim for Real Estate Professional Status…
- Is it better to work as an independent contractor than to have an LLC in Florida? – Those two things are not opposites. When you’re talking about from the tax side, you’re usually looking at it being paid as an independent contractor versus being an employee. We look at the pros and cons of this question.
- Would a new start-up with no revenue for the first two years file taxes for those years or only when the third year when the revenue was generated? – If it’s a partnership or C Corp, you may not have to pay taxes if there’s no income. It depends on how your business is set up.
- Additional Q&A listener chat questions are addressed
Resources:
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Full Episode Transcript:
This is the Anderson business adviser’s podcast. The show for real estate investors, stock traders and business owners. We help you keep more of what you earn and protect what you’ve built. Let’s get started.
Amanda: Hi, everyone. Welcome to Tax Tuesday. My name is Amanda Wynalda, and this is…
Eliot: Eliot Thomas.
Amanda: We’re just going to take a few minutes to get everyone online. For those of you who are joining us, again, welcome. For those of you who have never joined us before, you are in for some tax fun. I know that sounds like an oxymoron. But we’re all nerds here, so we love it. We love tax.
We’re bringing knowledge to the masses. Why don’t you go ahead and put up into chat? We want to know where everyone’s joining us from. It’s always fun to see. We’re based out of Las Vegas, Nevada, the fabulous sin city, but we keep it PG here at Anderson. Anderson also has offices in Draper, Utah, Tacoma, Washington, Cheyenne, Wyoming.
Eliot: For Anderson US. Yeah.
Amanda: Yeah. Anderson Global, check us out. We’re going global. We’re taking over the world like the T Swift of tax and legal. All right, we got someone from Vegas. If you’re in Vegas and you want to be a client, you can come meet us in person. That’s always fun. We don’t get to see everyone in person. What else we got in the chat? Hawaii, love it. Florida. Always a lot of clients in Florida.
Eliot: Yes. Yeah, a lot of good tax there.
Amanda: Good tax?
Eliot: Good taxes. No tax.
Amanda: No state tax. A lot of influx of people going from Cal. I’m originally from California. We have a lot of clients in California. They’re all like, peace out, California, going everywhere. All right. Let’s get to this.
Tax Tuesday Rules. This is a live Q&A, so please put your questions for our team. We’ve got a whole host of tax pros here with us, CPAs, attorneys, and stuff like that. Put your questions into the Q&A. The chat is used more for if you’re having any technical difficulties, our events team back there can help you out.
We have a set of nine questions today. We’ll go over those. If you want to submit questions, you can email them to taxtuesday@andersonadvisors.com. Sir Eliot here, if you say something really nice about him, he might pick your question for next time. He reads through all the hundreds of questions that we get and picks the ones for every Tuesday.
If you need a detailed response, you can become what’s called a platinum client. Our platinum membership is a monthly membership that gives you access to our tax and attorney team to ask whatever question you like. Trust me, you will not have the most insane question we’ve ever heard. That is a fact. This is a really fun educational way for us to reach out to the masses. We always like to say, Anderson is an education company first, so we love doing this type of thing.
We’re going to move to our next slide here, opening questions. All right. We’ve got nine questions. Let’s take turns reading them. You can go first. I’ve been talking a lot already.
Eliot: You’re doing good at it. “Is there any capital gains tax when my son inherits my property or stock?” It’s a popular question, we get that a lot.
Amanda: The second question we’re going to go over, “It’s time selling my home in South Florida soon and would like to relocate to North Carolina. I would like to reinvest a portion into a rental property and another smaller home when I move to North Carolina. What’s the best way to pay the least amount of capital gains taxes after selling my Florida home?”
Eliot: Popular question too. “How does a 1031 exchange work? What about a reverse 1031?” In fact, when we were getting ready for this, we probably had a good 20% of the questions. That’s a lot, all about 1031, so we’re going to try and give you a. background information.
Amanda: Yeah. Very popular strategy to save on taxes, especially with the higher interest rates.
Eliot: Yes.
Amanda: All right. “If I’m selling a property where not all the investors want to roll their money into a future investment through a 1031 exchange, is there a legal way to still do a 1031 for the investors that want to participate?” I like how they clarified with a legal way. We’re only going to show you legal ways, so thank you.
Eliot: Cross out a lot of ideas. We had a lot of other ideas, but none of them illegal. We’ll look at that. I have recently opened my Wyoming LLC. I set up a business bank account for the LLC and funded the LLC out of my personal account. I have since used the deposit of funds to make a limited partnership investment in a syndication. How do I best document these transactions for tax purposes?” We’re going to get some detailed information about, how do we track, document, what’s the best way to do for a tax purpose?
Amanda: You might even phone a friend on that.
Eliot: Yeah, we’re going to probably do that.
Amanda: We have a backup. “If my LLC distributes dividends to the partners, do the partners pay tax from the money they receive from the LLC?”
Eliot: Good question. “Should I take depreciation on a rental property if I don’t have a tenant that year, or should I wait until finishing repair although it is habitable? I’m a licensed realtor, by the way.”
Amanda: That’s actually some good additional information that opens up some other possibilities for us. “Is it better to work as an independent contractor than to have an LLC in Florida?”
Eliot: Lots of things we know about that.
Amanda: A lot of people in Florida, they got a lot of questions.
Eliot: Yeah, they were asking a lot. “Would a new startup with no revenue for the first two years file taxes for those years or only when the third year when the revenue was generated?”
Amanda: A lot of topics there. All right, this is our fearless leader, Toby Mathis. You most likely found us through this YouTube channel. He’s a YouTube star. He has one of those YouTube things in his office that’s the plaque, the award. I guess he’s gone multi platinum as they say or something. He gets those every year.
This is his channel. You can also join on YouTube. We’ve got somebody, one of our pros, in the background answering questions on YouTube. All of these Tax Tuesdays, although we’re live now, the recorded version will be posted to this YouTube channel. So please like, subscribe, and all that good stuff. Smash that subscribe button.
Eliot: We got this other guy.
Amanda: One of our other partners, Clint Coons’ based over at Tacoma office. He also has a YouTube channel that deals more on the asset protection side of things, but you get a little bit of both on both.
We also have our upcoming tax and asset protection workshop. Anderson’s really great because it’s tax and legal under one roof. You may not speak legal or tax, and you don’t have to because we speak both. You’re not having to translate between multiple professionals.
We’ve got our Tax and Asset Protection Workshop coming up on June 8th. That’s a virtual event. Then June 15th, which is also a virtual event. But if you want to come see us live in Dallas, we will be there June 27th through 29th. That’s really fun. You don’t get to go.
Eliot: No, I don’t go.
Amanda: It’ll be at the ones in Vegas. I’ll be there. I’ll be flying in from Hawaii, actually.
Eliot: Very nice.
Amanda: That’s how much of a tax nerd I am. I’m leaving my family in Hawaii a day early to go hang out and talk about tax in Dallas. We’ll have a bunch of attorneys. Michael Bowman will be there, who’s our other partner, Clint Coons, Toby Mathis, as well as a bunch of vendors, different affiliates, and guest speakers. It’s really a fun time.
Eliot: Great chance to get ideas from one another…
Amanda: Totally, a great networking event. Again, subscribe on our Anderson YouTube. You can see the link there for the replays. Let’s get this party started, Eliot. Is there any capital gains tax when my son inherits my property or stock?
Eliot: As always, it depends, but generally speaking, it is.
Amanda: That’s what you’re going to get here.
Eliot: A lot of that, except for the illegal that we talked about in that other question. Your capital gains, you can inherit. You get a stepped up basis when you inherit. If we had your traditional stock, let’s say it was AT&T or something like that, you can leave it to your child. They get it at the fair market value on the date when you passed or six months later, but nonetheless, it’s basically this fair market value at the time that you pass. They could sell right away and not pay any tax on it.
There’s also just a lifetime gift tax exclusion of approximately $13 million. I think it’s about $13.6 million. It goes up a little bit each year. You can combine that in a spousal situation, basically that’s $27 million. We’re really not talking a lot of tax for inheriting until we get a lot of money.
Amanda: Yeah. That means if your son is inheriting and your estate is over, if you’re single and your estate’s over $13.6 million, your state would pay the 40% estate tax only on the amount above that. Most people are not falling well below that. There’s no capital gains tax to transfer it to your son if you’re gifting it or if you’re passing it to him when you pass away.
Eliot: As we were talking about earlier, there’s also the concept of what we call stepped up basis. Your son’s going to get it at the fair market value again. That is going to tie in with this as well, so we want to cover that. There is another contingency that we run into now and then, where we’ve had clients who put something that’s appreciated value into an S-corporation or C-corp.
Amanda: Then we’re talking two different issues when it comes to the capital asset and what your basis in the property is.
Eliot: Let’s walk through just a quick example. If you had a C-corp, you wanted to leave it to somebody, they’re going to get the stepped up basis in the share value of that C-corp or S-corp. It’s going to be based even by that appreciated value. In other words, if we have a rental in our S or C-corp, we look at the fair market value when they inherit. That’s going to give you the value of the shares. That’s how they determine the value of shares. In that sense, you get the stepped up. If they were to sell right away, the whole corporation, then that’d be good.
What if they want to keep it as a rental down the future? Maybe it’s an S-corp, there’s a rental, and we’re just going to leave our kids the shares of the S-corp, then we have a different problem with depreciation. Any ideas what might happen there? The house itself, remember it doesn’t change. It gets owned by the corporation. If we’ve already been taking depreciation, we have something called adjusted basis, which is just the original fair market value, less depreciation over the years, that’s the corporation’s assets, S or C-corp.
Someone inherits it, they still own the S corporation. That’s correct, but there’s no stepped up basis to the S-corp in the asset itself. They’re going to keep that old straight line depreciation or worse, yet, if it’s already fully depreciated, there’s no depreciation going forward. Even though we just inherited and we got the stepped up basis of the value of stock, we don’t have any benefit and boy, do we look to depreciation for a lot of our deductions in our strategies.
Some things to consider, don’t panic if you happen to have an entity that has property in it, but you may want to talk to us. We’re not talking about flipping property. That’s something different. That’s where we do use your corporations. But if you do run into this, talk to one of our business advisors, get in to the Anderson team here. Maybe we can help you.
Amanda: Okay. Next one. “Hi, I’m selling my home in South Florida soon and would like to relocate to North Carolina. I would like to invest a portion into a rental property and another smaller home when I move to North Carolina. What is the best way to pay the least amount of capital gains taxes after selling my Florida home?” When we say home, we’re going to assume from this question that you’re talking about your primary residence, which immediately should bring to mind the 121 exclusion.
Eliot: Right. Our 121 exclusion is just saying that if we’ve lived there and owned it for two of the last five years, you can exclude up to a quarter million single, $500,000 married filing. Right there, we got a huge tax savings.
Amanda: Yeah. If your property is below that, or you sell below that, then you’ve already excluded all of the gain from the sale. You’re not going to pay any tax. The actual rule is two of the last five years. Those years do not need to be consecutive, so you could have moved out of the property, lived in it for a year, moved out, moved back in for another year, as long as it’s within that five-year timeframe.
There are some slight modifications if you are in the military and you’re forced to move for active service. There are some exceptions where you don’t have to quite meet the two out of the five year rule, but for the most part, that’s not going to apply to other people. If you’re selling the home for less than $250,000 if you’re single and $500,000 if you’re married filing jointly, you don’t have to worry about any capital gains.
Let’s assume that we’re selling for more than that. You’ve used your 121 exclusion to exclude some of the capital gain, but then you still have some on top of that. What can we do?
Eliot: We talked about maybe putting into other investments. As he mentioned, here’s another rental property. I want to step back just historically in this area of the tax code, because it used to be not so terribly long ago for people my age that when you sold your primary residency, if you spend all the cash on a new one, then you wouldn’t pay tax. That’s gone. That was replaced by the 121 that Amanda just described.
Maybe people still cling to that and think, well, if I spend the funds into a new investment, I don’t have to pay tax, that’s not a case anymore. Now, with Amanda’s criteria here, we’ve sold it. We’ve gone above our 1.1 exclusion, so we have extra cash, and maybe we do get a rental.
Immediately just buying the rental in and of itself may not help us, but we might have some other tools that we can use. We were talking about Amanda had a great idea before the show about harvesting capital gains losses. Can you explain a little bit about it?
Amanda: Yeah. Because it’s a capital asset and you’re looking to offset your capital gains, any other capital losses or even ordinary loss you can generate on your tax return for that year is going to help reduce that tax liability. If you have loser stocks, you can do loss harvesting. A lot of brokerage firms, you can just click a button and they’ll automatically do that for you, so it’s built in, or you can do it yourself if you are stock savvy.
If you own other businesses that are maybe operating at a loss or you can sell at a loss, it depends what other things you have going on. If we don’t have any of those other options and we’re just looking at this secondary property, this rental property, you can actually use it in such a way or rent it in such a way to generate some of these losses.
Eliot: That’s correct. Two primary methods of that would be one short term rental. That typically just means that the average stay of someone staying there is less than seven days throughout the year. If you materially participate, you’re the one running the show on that short term rental, you manage it yourself pretty much is the idea, then maybe we can do some depreciation tricks on there.
Accelerated depreciation with cost segregation creates big losses. Those losses are just as Amanda was talking about. They’re ordinary. They’ll go against any other income on your return, especially your capital gains. Or we can go long term rental, but we have some more steps there if that’s going to help us out.
Amanda: Yes, you do have to qualify as what’s known as a real estate professional. That means that you’re spending 750 hours in your real estate trade or business. If you only have this one rental property, it’s going to be pretty hard to meet that rep standard. If you’re spending 750 hours on that one property, it’s probably not worth it even to keep it around. If you’ve got other rental properties already and you can elect to aggregate them all together, you spend 750 total, then you could potentially qualify for reps.
The second part of that qualification is you need to spend more than 50% of your personal services on your real estate. If you’ve got a full time job, you’re most likely not going to be able to do that. You’re spending 40 hours a week working. You’re not going to spend 41 hours a week on your real estate.
If you work part time, or if you have a spouse that works out within the home who doesn’t get paid with money like the IRS would recognize, then they can qualify as a real estate professional. You can meet this standard, which does the same thing as a short term rental strategy. It takes all of the losses generated by your rental properties. It turns them from passive losses into ordinary losses, and then you can use those to offset any type of tax liability, even the capital gains from the sale of your personal residence.
Eliot: There you have it. A lot there. Just to unpack it, again, we’re selling it. We’re going to get that 121 exclusion assuming this is our primary residency. We could sell some capital gains at a loss, and that would help offset our capital gains from that. We could maybe turn that new rental into a short term rental where it’s a little bit easier to take advantage of a cost segregation and bonus depreciation or the real estate professional on a long term rental that Amanda just described. Those are some options. Hopefully that helps you out.
Amanda: The great part about the short term rental strategy is that you don’t have to continue to operate this property as a short term rental. I did a mid term rental with our last personal residence, and it was terrible. Interacting with people who are literally only contacting you to complain is not something I want to do in my free time. You can actually do the short term rental strategy for this year. Take advantage of all the tax benefits and the next year just be like, you know what, I’m just going to run it as a long term rental.
Eliot: I think that was the property I’d mentioned. I went to a party there, and you mentioned that it was probably not a good place to party. Maybe it was at your house, and I didn’t know your purpose.
Amanda: Yeah. We came back to a broken pool table at one point. Okay. “How does a 1031 exchange work? And what about a reverse 1031?”
Eliot: Good questions. Again, we had a whole lot of 1031 going on this time around. Basically, you’re 1031, the idea is you’ve got an asset that was using business. This means a rental, commercial, short term rental, a single family home, or what have you. It’s not being flipped. It’s not inventory. It’s just a working asset. The idea here is that you want to sell it and not incur the gain or at least defer the gain. By doing that, what we say is sell, that’s the relinquished property, the property we gave up, and then you’re going to buy some new. We call that the replacement, and that’s your 1031 now.
There’s a lot more to it. We’ll get into that. The idea is that you do have certain very stringent timeframes. Forty-five days is the one we normally hear about 45/180. Forty-five says if I’m giving up a property, if I sell it, I have 45 days to tell somebody what I’m going to pick up to replace them, I have to have that in its stern 45 days, and then 180 days to get it all buttoned up. Who is that person that we tell? We got somebody that has to help us out here.
Amanda: That’s right. You can’t just do a 1031 exchange on your own. I’ve actually had clients saying, oh, I’m doing this as a 1031 exchange. You need a qualified intermediary or a QI. I asked them, who’s your qualified intermediary? They just have this confused look on their face. I’m like, you are not doing a 1031 exchange, you’re just selling your property. You need a qualified intermediary. You can just go out onto the intranet, the interwebs, and find one. They’re considered fiduciary, right?
Eliot: They’re getting there. There’s been some problems in the past, but they’re getting up to that.
Amanda: Definitely look at the Google reviews, but the qualified intermediary is going to pretty much call the shots. The funds from the sale will never hit your personal bank account. They’ll go to the qualified intermediary who will hold it for those 45 or 180 days, and then they’ll execute the purchase for the new property. The funds never actually hit your bank account.
Eliot: We talked about your traditional 1031. I give up, I relinquish a property, I have 45 days to list. What am I going to pick up for replacement? What about the reverse?
Amanda: The reverse is a reverse.
Eliot: It’s just a reverse. This time I’m actually selling first, then I’m selling the property first in a reverse 1031, and then I’m picking up. I have 45 days to buy the property, list which property I’m going to give up, and have to have it all done within 180 days.
Amanda: The deadlines are very strict. Eliot was just telling me you did a…
Eliot: Did a continuing education and fantastic professional in the 1031 business who is a QI. She’s given some really good examples of that 45 or 180 days. She often would run into a situation where maybe the client lives in West Coast, lives in LA, and the property happens to be in Miami. If they get down to that 45 days, they’d have to have that list in there or the 180 days. It has to be done by midnight of that time zone where the property is located. They do not mess around with that, it’s very strict.
Amanda: Yeah. If you’re West Coast or even on Hawaii time, you better get on East Coast time for that one.
Eliot: Yes, exactly. Right.
Amanda: All right. “If I’m selling a property where not all the investors want to roll their money into a future investment through a 1031 exchange, is there a legal way to still do a 1031 for the investors that want to participate?”
Eliot: Excellent question. We get this a lot. We’re making another assumption here that probably we’re talking about a partnership. When we have a partnership, it’s the partnership that actually owns the property. If a man and I have a partnership, and we have a rental in there, it’s not like she can do a 1031, go off her way, and I don’t want to, because it’s the partnership that owns it. Neither of us own it.
That’s where we run into the situation proposed here, and this happens quite a bit. We get asked this a lot. There are some things that might be able to be done to fix this and facilitate a 1031 down the line, but they aren’t immediate fixes. In other words, what we can maybe do is we change it to where it’s a tenants in common, and now we own it as tenants in common, but basically, it would probably be outside of the partnership at that point, and then we can go our own ways.
She can 1031 her part, I can go spend my part, vice versa, or what have you. You often hear about a drop and swap, where basically we take the property down, jettison when maybe one of the partners that doesn’t want to be in there, pay them off, and then do the 1031 to the partnership that is staying around or something like that. There are some things that can be done like that, but none of these things can be done as we call it in anticipation of 1031.
The IRS doesn’t want us doing this right before 1031. There isn’t a whole lot of guidance out there for how long we have to wait either. You have to wait a reasonable time and just show the IRS, well, that wasn’t our intention for making this transactional change. The 1031 came out, it was an afterthought, that kind of thing. It’s what they’re looking at.
Amanda: Yeah. What the IRS will do is it’s not a statute. It’s not going to be found in the IRS code. It’s a legal doctrine that says if you do steps A, B, and C, and B is a superfluous step that didn’t really need to happen when the result was to just get from A to C, then they will truncate it and treat it as if you just did A and C. That’s what Eliot’s talking about in terms of doing a drop and swap or pulling a property out of a partnership to take somebody off.
If they look at it and say, well, what you were really trying to do was to get here, and you were just doing these other steps to get the tax benefits solely for the purpose of getting the tax benefits, then they’re not going to give you the tax benefits. You have to have some other business reason to pull it out of the partnership and get rid of that other partner.
Eliot: Exactly right. Collapsible transactions.
Amanda: Yeah. I think the thing that confuses people is, and we have clients come to us all the time that say, I own this property, I own that property, well, how it’s actually titled makes a big difference. If you own it through a partnership, yes, in your mind, you still own that property, but you don’t actually. You own the partnership, the partnership owns the property.
You could 1031 out of your partnership interests, but you would need a third party who would want to come in and replace you as the partner in that partnership if it’s with just a couple of partners that’s unlikely to happen. That happens on larger levels like Delaware statutory trust or bigger conglomerates. But if it’s just a few partners in a residential real estate, it’s unlikely you’re going to find a third party who wants to 1031 into your partnership that you put together.
Eliot: Excellent. There you have it.
Amanda: We’re flying through here. All right. “I’ve recently opened my Wyoming LLC, set up a business bank account for the LLC, funded the LLC out of my personal account. Those are all the right steps. I have since used the deposited funds to make a limited partnership investment in a syndication. How do I best document these transactions for tax purposes?”
Eliot: I’m going to tell you that any time to tax, all of our tax knowledge, everything we tell you is all going to be based on one thing, and that’s the bookkeeping. I think we are going to phone a friend. Is that right?
Amanda: We are. Troy?
Eliot: Troy, are you available out there?
Troy: Hello.
Amanda: Troy is the head of our bookkeeping department. I actually asked him exactly how, if you were sitting at the computer, putting this into QuickBooks or whatever accounting software, how would you do it? He told me that I’m going to let him tell you, because I don’t know if I could really repeat it.
Troy: All right. When you put money into your account from your personal account into your business bank account, that’s going to be a capital contribution. That’s going to be an equity account. How is your tax going to determine what equity account you will use?
Amanda: When you then make an investment into a syndication, how are you categorizing that transaction?
Troy: That is going to be an investment in X syndication or X company, and that’s going to show us an asset on your balance sheet. When you get a K-1 from that syndication at the end of the year, you can adjust to whatever the value of your investment is at that time.
Amanda: On the balance sheet, it’ll start out as the value of what you put in. It’ll be $100,000. When you get your K-1, it’s going to tell you whatever the new, hopefully increased value is, and you make that adjustment in your books.
Troy: Correct, right. Or if there was a ring at a loss, you’ll make that adjustment based upon the gain or the loss of the company.
Amanda: Right. If all of that sounded confusing to you, then we highly suggest you go and get professional bookkeeping. Anderson has professional bookkeeping. Troy, did you want to talk about a little bit of the new bookkeeping services we have?
Troy: I will gladly put a link in the chat to our bookkeeping website that lists out all of our different bookkeeping services. We have things for people that are just getting started out. We have things for people that don’t want to do their books anymore. We thank you for that because without that, I don’t have a job. So please sign up for bookkeeping services.
We also have things for people who are doing the books themselves and want to make sure everything’s done correctly. We have different services for all sorts of different people. I’ll put that link in chat now.
Amanda: We like Troy, so please help us keep him around.
Eliot: Yeah, exactly.
Troy: Yes, very important.
Amanda: I don’t like bookkeeping, that’s why I like other people to do the bookkeeping. But I will say that there is some merit to doing your own books, at least in the beginning, because you understand what’s going on at that level. Anyone who’s ever add any theft or something happened within their self-run companies, it’s always the bookkeeper.
You need to understand what’s going on, that’s why it’s really great to do your own books for a while, but at the same time, that’s not your skillset. If you were a bookkeeper, then maybe it is your job. But if you’re doing something else, or you’re moving and shaking and getting deals and that’s your skillset, then lean on professionals to do that thing.
Eliot: Absolutely. It does take some time, but I think that Amanda nailed it that it’s really important. It helps you really learn about your business, having a little bit of experience, but then it is time consuming. You want to tap on Troy and company to try and maybe help you out with that, take that time off your schedule.
Amanda: Outsource that. All right. “Should I take depreciation on a rental property if I don’t have a tenant that year, or should I wait until I finish repairing, although the property is habitable? I’m a licensed realtor, by the way.”
Eliot: Great question.
Amanda: Let’s start off with what is depreciation?
Eliot: Yeah. Okay, perfect. At the very beginning, you originally purchased a property. There was an amount that was the cost of the land and what we call the improvement, the building itself. The building can be what we call depreciated. You take a little bit of the expenses of deduction each year. We don’t get to deduct the whole thing right away, generally speaking.
Land is not appreciable, so we’re not going to be able to deduct that until the year we sell it. It sounds like maybe we’re doing some repair work here on this and adding, we call those improvements, perhaps. If there are improvements, that’s going to go on to the value of the house.
In other words, let’s say we bought a $500,000 house, $100,000 is the land value. That’s not going to change, but we have that building that’s $400,000, and maybe we did another $100,000 improvements on it. Now, our total value is $600,000, $500,000 for the house and land, $100,000 for the improvements, and the depreciable part is the $500,000. The house, which was $400,000, we added the improvements of $100,000, so we’re at a half a million there. We depreciate that over tradition, over straight line. We divide it by 27½ years if it’s a long term rental, typically, a single family. It takes a long time.
Amanda: That’s a long time. It’s even longer for commercial, 39 years.
Eliot: Exactly. It could be a long time. Short term rental, that would be a commercial use. If you had the traditional commercial building, all 39 years. There are some things that we can do to speed it up, cost segregation, and things like that. Bonus depreciation certainly is going to help us speed up how fast. We don’t add to the depreciation amount, we’re just going to speed it up. That’s one of the things.
When do we actually start incurring expenses and income if there’s any rent going on? There is a time frame that we reach, where we kind of flip the switch and start doing that. That’s what we call available for rent. It’s not a set term of what that means, but basically you’ve held it out for it. You probably go and put an ad out there in the paper, and it needs to be really rentable.
You can’t just put the end of the paper and then just not allow anybody to rent it because you’re not done with your repairs or something like that, but at least it has to be available for rent. That starts the clock of when we start taking deductions such as depreciation and things like that, recognizing income, other expenses, and things like that.
In our question here, should I take the depreciation on a rental property if I don’t have a tenant that year? First of all, you don’t have an option. I guess you do have an option. You have an option not to put the depreciation on your return, but the IRS is going to treat it as if you did. If you later on sell, they’re going to treat it as if you did take that depreciation, and you will not have had the benefit of that deduction all those years that you had it. To answer from that light, you don’t have an option. You have to take it. As long as it’s available for rent, you’re going to take your depreciation.
Amanda: Yeah. But just having the property habitable doesn’t mean that it’s necessarily available for rent. If you wanted to start taking the depreciation deduction, then you need the bare minimum. What you need to do is maybe list it on Zillow or Craigslist, then that would start it as being available for rent, and then you can start taking depreciation. How does the fact that this person’s a licensed realtor play into this?
Eliot: We talked about this a little bit in some of the previous questions. There’s a lot of angles we could go with that. If the hours that you’re putting in running this thing and management, perhaps, might help you go towards that real estate professional status we’re talking about, the 750 hours, over 50% of your work week or your personal services week. If you own your own licensed realtor business, maybe it’s an S-corporation get paid for, and you own over 5%, you’re hours just doing that outside of this rental, but just doing your basic job will go towards your 750 hours.
If it’s a short term rental, it actually doesn’t matter that we’re licensed or not. That in and of itself, it just might help us get hours, but you don’t have to be licensed to get to these states of material participation in case of a short term rental, a real estate professional in case of long term.
Amanda: Yeah. When we’re looking at timing, and we just started June, how likely is it that it’ll take the whole rest of the year to make repairs? I think of repairs as smaller things, not a capital improvement, which tends to take longer. If you’re looking to start taking depreciation and take advantage of some bonus depreciation with your real estate professional status, you don’t have to hold the property out for rent until the very end of the year. It just has to be before the end of the year.
Most likely you’re going to finish these repairs, and then you’re going to be able to start renting the property out, making some income, and then taking the depreciation to write it off. As long as that happens before the end of the year, you’re good.
Eliot: That’s a great point before the end of the year because that is a strategy that a lot of people take, maybe get the property towards the end of the year, really quick, get it out there for short term rental, put some time into it, so they can get that tax benefit. That is true. You just got to remember that you probably want to continue it as a short term rental into the next year a little bit.
We had Scott Estill here not long ago. He did a lot of work with Toby. He and Toby talked about in their episode about that, that if you have the short term rental and we’re going into the next year, you probably want to continue as a short terminal maybe into the next year, just to show the IRS that your whole intent wasn’t just to take immediate depreciation and then turn into long term rental.
Amanda pointed this out earlier in one of the questions that it doesn’t mean you have to be the one managing year two. It can still be a short term role, but you can get someone else to do it for you, but you got the heavy right off the first year because you were managing in that first year towards the end of the year.
Amanda: Yeah. The short answer is if the property is held out for rent, you should take depreciation because that’s going to be imputed onto you regardless by the IRS. If you’re looking to do something more creative like bonus depreciation, cost segregation, and you need those losses generated for this year, then you want to at least hold it out for rent before the end of the year.
Eliot: Good points. Just a reminder about the shows that we have coming up here.
Amanda: Our live tax and asset protection events. We’re doing two virtual events in June 8th and June 15th. You can register on our website, and then you’ll get an invitation to a Zoom link. It functions very similar to this. It’s in a different studio across the hall, but it’ll have a Q&A. We’ll have attorneys and tax professionals to answer all your questions.
It’s been described as drinking from a fire hose, all of your tax and asset protection needs. But if you’ve been looking through our YouTube channels and picking up on videos, this is where you’re going to get everything all in one place. There’s also some special offers there that are the best out there. Our live event in Dallas, if you want to come see us, please do.
Eliot: Great times.
Amanda: Cowboy hat not required. All right. “Is it better to work as an independent contractor than to have an LLC in Florida?” When I first read this question, it’s a little bit of a misnomer because you can be an independent contractor and have an LLC. Those two things are not opposites.
When you’re talking about from the tax side, you’re usually looking at being paid as an independent contractor versus being an employee. Let’s first start there. What are the pros and cons of being paid as an independent contractor versus an employee? Do you even have a choice when getting paid?
Eliot: Yeah, that’s a good point. Sometimes you don’t have a choice, but let’s just say you did. Being an independent contractor in and of itself, you get to set your own schedule a lot of times and things like that. Whereas an employee, you have traditional benefits and we’re told what to do. That’s just on the very surface of it. Of course, there are other differences. Independent contract or whatever they receive will be ordinary income, and it’s going to be subject to employment tax on a hundred percent of it.
Amanda: 15.3%.
Eliot: Not a small amount.
Amanda: When you’re a W-2 salaried employee, you do still pay employment taxes, but you’re only paying half, and then your company’s paying the other half.
Eliot: Exactly right, employer employee side of it. A little sharing of the load there on that. I think from a tax perspective, that’s probably one of the biggest differences between the two at that surface level. I would say, just because we talked about the one route, if you’re doing it as an individual, independent contractor in your own name, now comes in the evil lawsuit, you’re really exposed that 100% personal liability if you’re not doing it with an LLC.
We’re always going to tell you, don’t even think about a business without having an LLC, much less do anything. Certainly, just as Amanda pointed out at the beginning of this question, you want the regardless of what you’re going to do here. If you’re an independent contractor, don’t ever do it in your own.
Amanda: Yeah. The legal side of the question is not independent contractor versus LLC, it’s LLC versus operating as a sole proprietor. You never want to really do that. They’re treated fairly similar from a tax side, but for liability purposes, you want that limited liability protection of the LLC. For greater tax advantages, you can have an LLC and elect to have it taxed as an S-corporation, as a C-corporation. Depending on what other kinds of income you’ve got going on, there could be a tax benefit to either one of those.
Eliot: Absolutely. We got things like an S-corporation. The 280A, Augusta Rule meetings, that can be a significant tax play. You’re going to have some self-employments we just talked about in the beginning. In an S-corporation, you got 100% of the income coming through your S corporation. It’s a flow through entity. If you make $100, that’s all going to hit your personal 1040 return.
There, you only have to pay yourself a little bit of what’s called a reasonable wage, a W-2. You become an employee of your S-corp, but maybe you only have to pay $50 of that $100. as an employee, and that’s going to be subject to every tax the IRS can throw at us, income tax, employment taxes. That other $50 only going to get hit with income tax. You’re already well above and ahead from a tax standpoint than if you were just that independent contractor where Amanda was pointing out, all that’s subject to that 15.3. You’ve already saved just by making an S election. We got the 280A. What’s going on with 280A?
Amanda: 280A is often called the Augusta Rule. It’s the ability to rent out your personal residence for up to 14 days and completely tax free. You receive the rental income, and you don’t even report it on your tax return at all. You can combine this with your own business by renting your personal residence to your S-corporation.
You can hold a meeting, you can do a training session. You want to get quotes from local hotels or workspaces that are a conference room for a whole day, audio, visual, and all the different amenities that you have at your home. Any reasonable rate, which is actually any rate you can get, you can charge your company. That’s a deduction from the company as a meeting expense, and then it’s income to you completely tax free as long as you do it 14 days or less.
I had a client in Brooklyn. Obviously, Brooklyn is a very expensive town, Vegas, we get this as well. He got a quote for $3000 from a local hotel. He was able to charge his own company to have a meeting right there in his tiny little Brooklyn apartment, $3000 times 14 days of the year. That’s a really big deduction, and it’s a way to shift income that would normally hit your S-corporation and shift it into your pocket without any tax whatsoever.
Eliot: We also have what’s called the accountable plan, which, as I always say, is just fancy IRS language for reimbursement. One of the big things are there is if you have an administrative office. We talked about the meetings. That’s what Amanda was describing.
I always like to say, as an example, let’s say we have a thousand square foot home or apartment. We’ve got a back bedroom that’s a hundred square feet that we’re going to use as an office. Maybe we do the 280A up front in the kitchen, family room, or basement. It’s a big 1000 square feet. That’s where all the people will congregate for your meeting. We’re in that back bedroom, the hundred square feet, that’s where we’re going to have our office.
We would just take, typically this is just an estimate, a hundred square feet for the office divided by a thousand square feet for the whole place. That’s 10%. Now it’s 10% of all your costs. It could be rent, mortgage interest, property taxes, the whole gamut.
Amanda: Utilities, internet. If you’ve got clients coming over to your administrative office in your house, you can deduct landscaping, cleaning, all these normal business expenses. The difference between doing that and an LLC, taxes and S-corp, or just an LLC that would hit your schedule C, is that there’s a limit to that administrative office or home office on the schedule C.
Eliot: Yeah, it can be limited by the easy amount that everybody always takes. I think it’s $3 per square feet up to 500 square feet or something like 1500, as I recall. Nonetheless, it’s very poor compared to usually the average…
Amanda: The actual expenses.
Eliot: Exactly. Remember, basically, you’re allowing the tax code to pay 10% of your costs. That’s huge. There are actually things we can do to, I don’t want to say manipulate, that makes it sound bad, but improve that percentage. We can take out the square footage in our place for unusable areas like restrooms, hallways, and stairwells.
Let’s say, again, in our mammoth 1000 square foot, we have 200 square feet of that. Now we’re dividing 100 square foot office by 800 square feet, and that’s going to be about 12. 5%. We can etch it up there a little bit more, and it just gets better and better. You couple that with the 280A, you’re well on your way to tax. We didn’t even talk about it, that’s all the S-corp. But if we have a C-corp, we have another thing called a medical reimbursement. What’s going on there?
Amanda: Yeah. Any medical expenses, out of pocket medical expenses, you can essentially treat it the same way as expenses out of an accountable plan. You pay for them personally, you turn in an expense report to your company, and your company can reimburse you for those. When we talk about out of pocket medical, the shorthand version is anything you can get a doctor’s note for, prescriptions, life saving surgery, orthodontia, or things like that.
It’s not going to necessarily cover elective procedures or things. People always ask vitamins and supplements. That’s a different plan, but in the C-corp, you can do that medical reimbursement plan. That’s really a great option for people who have high medical expenses, but not high enough that you can take that deduction on your Schedule A because of that 10% floor.
Eliot: Yeah. Just like we did earlier, let’s just revamp and reset here. Independent contractor, certainly, it’s best that you have an LLC. Absolutely, you got to have the LLC for asset protection. We have a hundred dollars come through, and it’s subject to all the taxes the IRS can give us, income taxes, perhaps state taxes, employment taxes, and all that. Or we have an S or C-corporation where you can have some tax savings perhaps on your employment tax, you got the 280A, you got administrative office, maybe the medical reimbursement. It’s a no brainer. You just have so many tax goodies on the corporation
We don’t want to beat you up on the cost to set up. There are other formalities doing a return or something like that. We usually recommend as a rule of thumb, maybe you’re making $30,000 before we do that just to make it worthwhile. Toby always likes to see seven times his return on things. Not a bad rule of thumb, and he’s good at getting those. Here, there’s just some things to think about, but more than likely, yes, you’re going to want to be in a corporation LLC.
Amanda: Yup. LLC and then make $30,000 a year, you make that S selection. All right. “Would a new startup with no revenue for the first two years file taxes for those years or only in the third year when the revenue is generated?”
Eliot: I’m operating my business for two years. Maybe I’m going to start making money for the third year. Do I have a duty to file returns?
Amanda: You don’t if you don’t have income.
Eliot: Could be. What if I’m an S-corporation or a C-corporation, then I do. Exactly as Amanda has pointed out, if it’s a partnership, maybe I don’t. In fact, there are cases where we’ve had a C-corporation, where maybe we don’t have to file, we just say we didn’t start the business to later on. And that’s exactly right.
Amanda is absolutely correct. Many times you don’t if you haven’t made any income, but maybe I do want to capture those things on an S corporation, It’s a little bit different there because they do want us to file every year for there. It does depend, as always, on how we’re taxed in our business. We have this new startup. But you could potentially put it off.
If it’s a partnership, usually we don’t say until you start a business. You may not be able to capture those expenses though. That’s another aspect to it and just depends how much we have here going on. If there wasn’t a loss, some clients will forgo that.
Amanda: That’s the big one. This question usually comes up because there’s typically a cost to prepare a tax return. In your first couple of years, if you haven’t made any money, it’s not really fun to spend more money to file that tax return. Clients are coming in and asking, hey, can I get away with not filing this tax return, with not having more money go out the door before I have some money coming in?
Once we go through the analysis, most clients are actually filing the return, because if you don’t capture those expenses, then you lose them. Those expenses can go if you’ve got a Schedule C, sole proprietorship. But in an LLC, those losses generated by legal fees, by paying for a registered agent, by paying to set up the entity with the Secretary of State, for any type of subscriptions, or any expenses that you could take in that first year, that’s going to generate a loss. That loss can be used to offset other income on your tax return.
Let’s talk a little bit about the rules behind startup costs. This one’s talking about not filing a return for two years. If we’re looking at startup costs, typically you’re looking at the 12, maybe 18 months prior to starting the business. Are we then going to be able to capture those startup costs on that third year tax return? Because now we’re looking at expenses that we spent some three or four years ago.
Eliot: Right. The code itself doesn’t have a time limit. We could go back to expenses from 1776 if we wanted to.
Amanda: And Gold Bullion.
Eliot: There you go. Exactly. We were back on the gold standard. The problem here is that you got to have a much, much stronger connection to those expenses to your business. Clearly, that gets ridiculous after a certain point. Two years, we’ve certainly done it, but our rule of thumb really is about 18 months. That doesn’t mean we can’t go back because the code allows for it, but you’re really going to have to show that connection that those expenses were really towards starting up that business. Excellent question. We run into it a lot.
Amanda: We do. Taking those losses now, what happens if you don’t have any income to offset them? How do those carry forward? And what situations do those carry forward?
Eliot: We could have a net operating loss. Again, often it depends how we’re taxed. It will still going to be an NOL, net operating loss, either way, but a C corporation just keeps building. Once you have income, it will help wipe out a lot of that third year income that we have here.
There are some particular rules that maybe you can only offset up to 80% or something like that. That is true. But usually at third year, if you’ve had a lot of losses the first year and the third year doesn’t create so much that we’re out of bounds to be able to wipe out quite a bit of it. If it’s on your personal return and it’s just an ordinary NOL, then it will still wipe out, again same rules and limitations, but usually you can wipe out quite a bit of it.
Amanda: Yeah. There’s no downside really to filing the return.
Eliot: I’ve ran into this a couple of times. It’s been a while since we have hit this problem. For a while, probably about five to seven years ago, we would have clients who had a lot of R&D. They went out and spent a lot in research and development thinking that, well, I’m not going to set my entity up right now because I listened to Toby’s podcast or whatever it was. I heard that I can capture the startup costs. R&D is different, research and development.
We can’t do that. You’ve got to have a business already. You need to have that LLC as proof that you’re running a business in order to start using that R&D. That’s a little bit different. We cannot use R&D in startup costs, those costs we incur prior to setting up the business. I just throw them out there because I’ve seen a couple of clients, and they put a lot of money into that. They got stung on it not knowing that a small little caveat.
Amanda: All right, we’re going to hit you with our YouTube channel again. This is recorded. This is live now, but you can go on to Toby’s tax planning and asset protection YouTube website. Subscribe. Every two weeks, if you can’t make it to us live, you can get a notification that the recording will be up. We’ve got about eight more minutes. Should we check out the Q&A?
Eliot: Yeah. It looks like we’re at 99 questions already being answered by the whole team out there at 13 left open.
Amanda: It just went to a hundred.
Eliot: There we go.
Amanda: You guys are putting them to work. We love it. Okay, let’s start at the top. “Would the structure for anonymity charge and order protection be the property is held in a land or residence trust and to a Wyoming entity set up for property manage it that is also a qualified opportunity fund?
Eliot: They were talking probably about, obviously, a qualified opportunity zone property. We got a property out there going on. Typically, you’re going to set up the fund itself, which has to be, as I recall, a partnership or a corporation. We’re going to put money in there, and then it goes out and invests into another entity that actually has the property. I suppose you very well might use a land first though. I guess I haven’t seen one used, but I don’t know that you couldn’t.
Amanda: I don’t see that you couldn’t, how you hold title to the actual property itself as long as the beneficiary of that trust is the Qualified Opportunity Zone entity. I’ll be honest, Qualified Opportunity Zones were very popular in 2020. It’s like all tax rules or most tax rules. As time goes on, the benefit goes down. We don’t see a lot of people setting up opportunity zones right now, because you can’t meet the 10-year holding period to get the maximum tax benefit from it, so we don’t see a lot of that very much.
Eliot: Certainly, it would not be a residence trust. We use that for something different. I’d even be a little shy of the land trust, simply because corporate opportunities zone is a little bit different than our traditional structuring, and maybe they do require direct ownership. I haven’t heard that you can’t use it, but I’d be a little leery of that and may want to have that researched a little bit more.
Amanda: Yeah, for sure. Okay. Wow. That question just got a lot longer than it looked at first. Okay. This is a little bit like our Florida submitted question. “We’re potentially moving out of state for husband’s job, and we’re not sure if we’re wanting to rent or sell our lake house.” This person is a real estate professional, and the husband is a W2. “We have about $150,000 of equity, and the rent would likely be 25% to 30%.” I’m just going to read ahead and try to summarize.
If we put the residence into service in 2025, so looking at next year and cost seg rapidly to depreciate, but then sell in 2026, what happens tax wise? We’re looking at a property that we’ve turned into a rental. We’ve taken bonus depreciation on, so we’ve taken more than straight line more than the tiny bit of 27.5 years, but then you turn around and sell it. To me, this springs of depreciation recapture.
Eliot: Yeah. What is going on there? Depreciation recapture is just like it sounds. You take depreciation, they gave you a deduction, and now the government takes it away. They make you pay taxes at ordinary rates on that with a little asterisk on that up to 25%. Here, we talked about a cost segregation.
Let’s say we didn’t do the cost segment, and we’re just doing regular straight line depreciation. Under the code, it’s a little bit in depth, but that’s called 1250 property. You just have a house. When you do depreciation recapture, it’s going to be limited to 25%.
The problem is you want that heavy cost seg deduction, and then you break the house out into what’s called 1245 property. That’s your 5-year property, or 10, anything under 2015 year, and then you have the rest of the structure that’s still 27 1⁄2 or 39. That’s still 1250.
When you do depreciation recapture on that 1245, there isn’t a limit there. There’s not a 25 percent limit, so it’s going to be at your ordinary tax bracket rates. You’ve done yourself a favor early on by doing your cost seg. Getting all your write offs and everything that you mentioned there, but then you’re going to turn around and sell relatively quickly. Maybe we don’t get a whole lot, a lot is still going to get taxed. Really, you don’t know until you pencil it all out. That would take a little bit more of a consult there.
Amanda: Maybe in this situation, you’re thinking 1031.
Eliot: Right, exactly. That’s the very end. That’s all the questions we had today. You see how popular that is because now we could just defer the tax. Perhaps, that’s the next one I do. Absolutely. There you go.
Amanda: Again, for the third time, we will be reminding you of our tax and asset protection event. We got two virtual events on June 8th and 15th. I believe Toby and Clint will be hosting or teaching those. Our live event in Dallas, this is super fun. Please join us. They are really fun.
Eliot: Yeah. Everyone gets there, the clients love it. The staff gets to go out there, we don’t.
Amanda: I get to go, I’m special. It’s nice to put faces to names. We’re based in Vegas, so we deal with clients all over the country, sometimes all over the world, a lot of phone calls. Getting to meet people in person is super fun. All right, questions? Not for today, for next time. Email us, taxtuesday@andersonadvisors.com or visit us at Anderson Advisors.
How many times do you get a question at this point? This is episode 220. There are 220 other episodes probably better than this out there on the YouTube channel. How many new and novel questions do you get at this point?
Eliot: They still come up. I try and pull those if I can. I was like, hey, that’s really unique. We had one. Toby doesn’t really need to look at the questions beforehand. He just got to roll them here.
Amanda: He has a photocopy of the IRS code in his brain.
Eliot: This is all really true. Give me a little behind the scenes here. I thought this was really interesting. The client was investing in whiskey or something like that, and then they’d sell the whiskey. It’s obviously been around for several years or however long whiskey sits.
Amanda: A long time. I feel like that’s a hundred age barrel, a long time.
Eliot: They found it for some ship or something like that, so it’s got a story behind it.
Amanda: They found the whiskey on a shipwreck.
Eliot: I’m just going back up there. There’s some story behind it that the value goes up. Toby’s like, oh, yeah, I’ve invested in that, that’s da, da, da. The point to Amanda’s question is I look for questions like that. It’s like, wow, that’s really unique. I thought that would be a really neat one. And Toby’s like, oh yeah, I’ve done that.
Amanda: Tried to stump him, cannot do it.
Eliot: No, he can’t do it. The point is, please send us your questions because there’s always some little nuance to it that can maybe bring something up. If you are just looking for general tax info, we’ve got 219 other episodes besides this one to go back on the YouTube channel. You can search by keyword, things like that, and I’ll bring it up.
Eliot: We try and hit the broad questions. We had, like I said, over, I don’t know how many questions about 1031, so I try and throw some of those in there too. We get a little bit for everybody. I guess that’s it. Until next time, have a great two weeks.
Amanda: We’ll see you then.
Eliot: Thank you.
Amanda: Have a great day. Bye-bye.
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